Investors are typically not involved in the day-to-day operations of the investee company but they require certain governance related rights in the investee company to safeguard their investments and protect their interests. A common mechanism through which investors exercise certain level of control in the investee company is through board nomination. While the main objective of a nominee director is to represent the interests of the investor, he/she must also act in the best interests of the company as required under the Companies Act, 2013 (“2013 Act”).
LIABILITY OF NOMINEE DIRECTORS UNDER VARIOUS LEGISLATIONS AND CONFLICT OF INTERESTS
The 2013 Act explicitly enumerates the duties of a director. It is important to note that section 166 of the 2013 Act does not make any exception for non-executive directors which essentially means that all directors (including nominee directors) of a company will be bound by the provisions contained therein. Therefore, a nominee director will also be liable to comply with the provisions of section 166 of the 2013 Act which, inter-alia, provides that the director (a) must act in the best interests of the company, and (b) shall not be involved in a situation which directly or indirectly leads to conflict with the interests of the company. Considering the nominee director is appointed to safeguard the interests of the investor, he/she may often get in a difficult situation while protecting the interest of the investor and ensuring that the same does not conflict with the interests of the company. The situation becomes more challenging in the context of an investor affirmative vote matter, the sole purpose of which is to give certain rights to the investor in the decision-making process wherein even if majority of the directors have agreed to a particular action, the nominee director can veto against it if the same conflicts with the interest of the investor.
The conundrum on interest and responsibility of nominee director towards the shareholders and nominators is not a new concern. In the case of Aes Opgc Holding (Mauritius) and Others vs Orissa Power Generation and Others (2005 125 CompCas 299 CLB), the following was observed: “Conflict of interest would arise when a person owes allegiance to two or more entities/persons and is placed in a situation to take a decision which would affect the interest of all those to which/whom he owes allegiance. If a director of a company is placed in such a situation either he should recluse himself or he is duty bound to take the decision which would be in the interest of the company failing which he would be in breach of his fiduciary duties. It is more so in case of nominee directors when there is a clash of interest between the company and their nominators…”. This rationale has been upheld in various foreign judgments as well.
Section 149(12) of the 2013 Act provides that a non-executive director shall be held liable for such acts of omission or commission by a company which had occurred with the knowledge of such director, attributable through board processes and with his/her consent and connivance or where he/she did not act diligently. A recent circular issued by the Ministry of Corporate Affairs dated March 02, 2020 (“Circular”) clarified that non-executive directors, not being whole-time directors who are involved in the day-to-day activities of a company must not be unnecessarily arrayed in any civil or criminal proceedings unless the criteria under Section 149(12) of the 2013 Act is met. Thus, a nominee director needs to understand the matter on which he/she is voting and the consequences thereof. Even though a certain level of protection is given to non-executive directors as is evident from the Circular, the argument that a nominee director is not involved in the day-to-day operations of the investee company and has primary responsibility towards the nominator may not aid in absolving him/her from any liability which may arise.
Section 179 of the Income Tax Act, 1961 (“Income Tax Act”) provides that if any tax due from a private company in respect of any income of any previous year or from any other company in respect of any income of any previous year during which such other company was a private company cannot be recovered, then, every person who was a director of the private company at any time during the relevant previous year shall be jointly and severally liable for the payment of such tax unless he proves that the non-recovery cannot be attributed to any gross neglect, misfeasance or breach of duty on his part in relation to the affairs of the company. Section 89 of the Central Goods and Services Tax Act, 2017 also lays out the liability of directors of a private company which is similar to the provision under the Income Tax Act. Section 49 of the Legal Metrology Act, 2009 (“Legal Metrology Act”) also imposes liability on the directors of the company for any non-compliances specified thereunder.
MINIMIZING LIABILITY OF NOMINEE DIRECTORS
One of the most common ways to protect directors of a company from personal liability that may arise for acts done in their managerial capacity is by ensuring that the company takes requisite directors & officers liability insurance. While the 1956 Act had restrictions on indemnifying directors against any liability, such a restriction does not find any mention in the 2013 Act. The nominee director and the investee company may also enter into a separate indemnification agreement stipulating additional indemnity obligations of the company and promoters in respect of any loss which the nominee director may be subject to.
A governing body structure may be provided in the shareholders’ agreement at the time of documenting the rights and obligations of the investors vis-à-vis the other shareholders of the investee company. The governing body may have the same composition as the board of directors. All decisions to be taken at a board meeting may be discussed in the meeting of the governing body which includes the investor nominee as well. Once the governing body has taken a decision, the board should act as per the decision of the governing body. Therefore, the investor may not appoint a director to the board of the investee company and consequently, will not be subject to the statutory liabilities which may become applicable on a director and at the same time, the interests of the investor can be safeguarded via the governing body. However, this modality will need to be evaluated from an ease of operations perspective as well.
The major conflict arises in the event the investee company is taking a decision on any investor affirmative matters. One way to tackle this situation is by creating a mechanism wherein the consent of the nominee director (or any nominee of the investor) with respect to an investor affirmative matter is taken prior to the matter being introduced at the board level. The board shall act in accordance with such consent and the company proceeds to decide on such matter only once approval of the investor is granted in respect of such matter.
The investor must ensure that an appropriate individual is appointed by the investee company as an officer-in-default in accordance with the provisions of the 2013 Act and Form e-GNL-3 is filed with the Registrar of Companies.
In recent times, authorities under the Legal Metrology Act have been serving notices on companies and their directors with respect to non-compliances thereunder. In light of the same, it is vital to ensure that the investee company authorizes one of its directors as the person responsible to ensure compliances with the Legal Metrology Act. This may be included as a condition precedent or condition subsequent in the transaction documents.
These measures will secure the interest of the investor as well as allow the investor nominee director to act in accordance with their fiduciary duty. Even though a nominee director is appointed to safeguard the interests of the nominator, the fact is that the interests of the company should be over and above the interests of his/her nominator. While it may appear easy to attain a balance in protecting interests of nominator and the investee company, there are various practical difficulties and myriad risks faced by the parties while doing so. Therefore, investors must adopt an extra cautious approach while negotiating transaction documents and ensure to limit the liability that their nominee director may be exposed to.